Restructuring and Managing the Telecommunications Sector

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Restructuring and Managing the Telecommunications Sector

Edited by

Björn Wellenius, Peter A. Stern, Timothy E. Nulty, and Richard D. Stern

1818 H Street, N.W., Washington, D.C. 20433, U.S.A.

Manufactured in the United States of America First printing May 1989

Fifth printing June 1997

The findings, interpretations, and conclusions expressed in this study are entirely those of the authors and should not be attributed in any manner to the World Bank, to its affiliated organizations, or to members of its Board of Executive Directors or the countries they represent.

Library of Congress Cataloging−in−Publication Data Restructuring and managing

the telecommunications sector (A World Bank Symposium)

Based on a seminar held in Kuala Lumpur, Malaysia, Nov. 1719, 1987.

1. Telecommunications—Asia—Congresses. 2. Tele−

communication policy—Asia—Congresses. 3. Telecommuni−

cation—Congresses. 4. Telecommunication policy—Con−

gresses. I. Wellenius, Bjorn. II. International Bank for Reconstruction and Development. III. Series.

HE8342.R47 1989 384'.041 89−5773 ISBN 0−8213−1198−0break

FOREWORD

As economic activity reaches a global scale and becomes critically dependent on vastly expanded flows of information, telecommunications is acquiring strategic importance for economic growth and development. At the same time, rapid innovation in telecommunications and information technology is lowering costs, creating new services and ways of delivering traditional services, and changing the cost structure of many other industries. In response to these forces, most developed countries are now at some stage of restructuring their

telecommunications sectors. A growing number of developing countries, recognizing telecommunications as a key element of economic development, are looking into reforms that may also help overcome persistent shortfalls

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in telecommunications investment and performance. And international development organizations have in recent years broadened their approach to telecommunications to include the examination of a wide range of sector policy issues and options.

This volume reflects the considerable attention that these issues and options have received in countries of very different economic conditions. The seminar on which this publication is based was the third in a series jointly organized by the World Bank and the Commonwealth Telecommunications Organization. After the first two, which had focused mainly on management problems of telecommunications enterprises, the need for a meeting on broader sectoral issues became evident. This seminar eloquently confirmed the developing countries' interest in structural change and in the developed countries' experience.

The World Bank and the Commonwealth Telecommunications Organization hope that the wide distribution of the material included in this volume will stimulate further thinking and discussion on this very important subject, the impact of which by far transcends the telecommunications sector. Both organizations stand ready to facilitate such reflection.break

ATTILA KARAOSMANOGLU VICE PRESIDENT, ASIA REGION THE WORLD BANK

MAURICE GILHAM CHAIRMAN

COMMONWEALTH TELECOMMUNICATIONS COUNCIL

PREFACE

In response to the winds of change that have swept through the telecommunications industry worldwide, the World Bank, the Commonwealth Telecommunications Organisation, and Syarikat Telecom Malaysia organized a seminar on the management and restructuring of the sector. More than sixty participants gathered in Kuala Lumpur, Malaysia, on November 1719, 1987. They included chief executives and senior managers of virtually all major Asian telecommunications enterprises (from both industrialized and developing countries) and selected others.

The seminar's broad objective was to identify key telecommunications policy issues and to consider alternatives for sector development by examining actual experiences in a wide cross section of countries. More specifically, the seminar sought to inform policymakers and operators in developing countries and newly industrialized countries of the emerging options for telecommunications sector policy, structure, and regulation. Another goal was to give these participants the opportunity to exchange ideas among themselves and to learn from the

experience of countries (industrialized and developing) that have undertaken sector reform or are now embarking on it.

The seminar was eminently successful in achieving its objectives. It confirmed the developing countries' growing interest in new sectoral approaches in the context of the rapidly changing world telecommunications business environment and also demonstrated the relevance of the industrialized countries' experience.

The present volume disseminates the knowledge and lessons drawn from the seminar. In this sense, the book takes a first step in implementing the seminar participants' recommendation that the World Bank and other international agencies step up their efforts to facilitate the exchange of experience on telecommunications sector reform among countries. More specifically, ready access to the material presented here is expected to facilitate the dialogue both among government authorities responsible for telecommunications policy—in the areas of finance, planning, and economy as well as communication—and with the telecommunications operating entities, major users, potential

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investors, and other key participants in the telecommunications business. The book may also give international agencies a better understanding of the role they can play in helping address increasingly critical communication constraints on economic and social development. Most chapters are based on the papers presented at Kuala Lumpur, and some material has been added (mainly Chapters 1, 3, and 17).

The success of the seminar, and this volume, owe much to people who participated in the conception and organization stages but were not present in Kuala Lumpur. We particularly thank Steven Ettinger of the World Bank. Part of the material presented, especially Chapters 2 and 12, draws heavily on the collective work of the World Bank's telecommunications staff and consultants; especially valuable contributions were made to these chapters by Stephen Brushett, Gerald Buttex, Nikola Holcer, Dinshaw Joshi, Rogati Kayani, Hugh Lantzke, David Lomax, Shanta Pai, A. Shanmugarajah, Mark Tomlinson, and others. The views expressed in these pages, however, do not necessarily reflect those of the participating organizations.

For excellent local seminar organization and support and for generous hospitality we are grateful to Syarikat Telekom Malaysia Berhad, especially to the chairman, Tan Sri Dato' Dr. Mohd Rasdan Bin Haji Baba, and the managing director, Daud bin Isahak, as well as to Mohdcontinue

Radzi bin Mansor (executive director), Rusli bin Habib (general manager, Telecommunications Training Centre), and many members of the devoted staff. Peter Chang (TELEGLOBE Canada) very ably assisted in the

organization on behalf of the Commonwealth Telecommunication Organization.

The editors are also grateful to Robert Bruce, Jeffrey Cunard, and Karen Brinkmann of Debevoise and Plmpton and to Alain Morissette, director, and Andy Lauriston, senior terminologist, Language Services, TELEGLOBE Canada, for their kind assistance in preparing the glossary of terms in this volume.

Finally, the organizers and editors express heartfelt thanks to all seminar participants and authors and to Amnon Golan for his superb chairmanship.break

1—

Structural Change in Telecommunications

Björn Wellenius and Peter A. Stern

Driven by powerful technological and market forces, the telecommunications revolution has assumed global dimensions. Starting in the United States in the early 1970s, structural change swept the telecommunications sectors of the United Kingdom and Japan in the early 1980s and is now well under way in most countries of the Organisation for Economic Cooperation and Development (OECD). The same pressures and the beginnings of sector reform have most recently started to appear among developing countries and in the Eastern bloc.

Telecommunications has traditionally been viewed as a natural monopoly and a relatively straightforward public utility. Economies of scale, political and military sensitivities, and large externalities made telecommunications a typical public service. In such an environment, development focused primarily on extending basic services and secondarily on improving the operational performance of the telecommunications operating entities.

In recent years the situation has changed dramatically. There has emerged a strong business demand for better, more varied, and less costly communications services. This demand reflects the growing importance of

communication in all economic sectors, the convergence of information and telecommunication services, and the globalization of capital flows, trade, manufacturing, and other activities. Technological innovation has greatly

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reduced the cost of information processing and transmission and has created new ways of meeting a wider range of user needs independent of existing telecommunications enterprises and often at lower cost.

Industrialized countries, in which these forces first emerged in full strength, are responding to the profound changes in telecommunications by revising the policy framework, structure, and regulation of the sector. These developments in turn promote competition, increase the number of participants in the telecommunications business, and blur the boundaries not only between users and providers but also among the various types of services offered. In addition the changes expand telecommunications markets globally and unleash powerful forces seeking new opportunities worldwide.

Where do developing countries stand in this context?

With few exceptions, in the developing world telecommunications services are provided by the public sector.

These services yield high economic returns, benefit a broad cross section of the population, and are used mainly for economic production and distribution. They can also be a profitable business and an important source of public funds. Despite the high social and private returns, however, developing countries generally invest too little in telecommunications. As a result there is high unmet demand for basic services, call congestion, excessive concentration in a few urban centers, and a lack of the advanced services that are increasingly needed by the modern sectors of the economy. Furthermore, facilities are often badly maintained and operated, so that service quality and reliability are poor. These problems are largely traceable to inadequate sector policies, a shortage of funds (especially foreign exchange) for investment, and weaknesses in the operating entities' organization and management.

There is evidence that the pressures on the telecommunications sector in the advanced economies are increasingly felt in developing countries as well. Consequently, attractive opportunities to deal with the sector's inadequacies are emerging. Some developingcontinue

countries are considering alternatives to the traditional state monopoly that would increase the autonomy and commercial orientation of the enterprise, attract private participation, and introduce competitive discipline. These alternatives are expected to help raise investment levels, mobilize new sources of capital, attract entrepreneurial talent, improve enterprise efficiency, and increase responsiveness to user demands. Such undertakings, however, raise broad policy and regulatory issues that many developing country governments may not yet be well equipped to address.

Overview

This volume addresses these issues and presents the experiences of various countries that have restructured their telecommunications sector to adjust to the changing environment.

The book is organized in four parts. Part I establishes the conceptual framework. It examines and discusses the forces for change in the telecommunications sector in the industrialized and the developing worlds, the constraints on operating entities, national policy issues, sector structure issues, and the various strategic options available to the countries (Chapter 2). Although the options most frequently perceived are competition in networks and customer premises equipment, Chapter 3 analyzes another option that is currently the center of major debate, namely, service competition. Using as an example the typical regulatory structure of the United States at the state level, Chapter 4 describes the elements of regulation and proposes a regulatory structure for the orderly

development of an increasingly complex and competitive sector.

Part II describes the experience of industrialized countries with telecommunications sector reform. Some of the structural and regulatory options that are being implemented or explored in Europe, North America, and the

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Pacific Rim are reviewed in Chapter 5, which also examines the external factors that are affecting national policy in these OECD countries and suggests various policy options for consideration by policymakers rather than as models to be emulated. Actual experiences in the United Kingdom, Japan, New Zealand, Australia, and the United States are described in Chapters 6 to 11. Chapter 6 discusses the forces and events that preceded the introduction of competition in the United Kingdom and the privatization of British Telecom in 1984; it candidly assesses the impact on and current impressions of each major stakeholder (that is, the customers, the shareholders, the employees, the government, the regulator, and the media). Chapter 7 describes the facilities−services type of regulatory structure that was chosen for Japan, which is embodied in the 1985 Telecommunications Business Law. The chapter reviews the status of competition in both the facilities (Type I) and services (Type II) fields as well as in the national and international arenas. As an example of current international policy considerations, Chapter 7 discusses the terms and conditions for value−added services competition currently being negotiated between Japan and the United States. The impact of these structural changes on the former domestic (Nippon Telegraph and Telephone) and international (Kokusai Denshin Denwa) state−owned monopoly carriers are described in both Chapters 7 and 8. Chapter 9 describes the first step in liberalizing the telecommunications sector in New Zealand, the splitting up of the New Zealand Post Office and the restructuring of its telecommunications operation as a corporation. The government of New Zealand has clearly stated that the overall economic objective toward which it is working involves liberalization and competition, clarification of social and economic policies, and the separation of commercial and noncommercial activities. The forces of change noted in earlier chapters are also present in Australia; however, because of Australia's particular demographic, geographic, and economic characteristics, Chapter 10 suggests that the best policy option for this vast and sparsely populated country is to strike a balance ''between the long−standing emphasis on telecommunications as a universal service and the more recent opportunities and imperatives for service differentiation." The chapter also reviews briefly the

organizational changes taking place within Telecom Australia (the domestic carrier) in anticipation of sectoral changes. Chapter 11 sketches the transition in the United States from monopoly provision of telecommunications services to competition and deregulation. It examines markets, such as those for customer premises equipment and certain network equipment, where in the author's opinion competition has been successfully implemented.

Competition in short−haul toll service is perceived to be far from perfect, and comments are offered on further liberalization in the United States.

Part III presents the experiences of developing countries. Chapter 12 provides the necessary background by reviewing the basic features that characterize the telecommunications sector in developing countries: service provision by a public sector monopoly; underinvestment; inadequate sector policies; and weak organization, management, and personnel policies. Chapter 12 then reviews three general directions of change in developing countries. These are also described in other terms in Part I and involve the shifting of operations away from government, the re−soft

duction of monopoly scope (including the introduction of competition), and the separation and strengthening of the policy and regulatory functions. Changes currently under way in some thirty developing countries are briefly described. Chapter 13 discusses the way in which the forces of change have persuaded the government of Sri Lanka to restructure. Of particular interest is a brief outline of the procedures followed, from the government's establishment of a Presidential Committee of Inquiry, to the passing of necessary legislation to set up the operator and regulatory body, and finally to the institution of a self−liquidating board (responsible to the head of state) to implement privatization and encourage foreign collaboration. Chapters 14 and 15 examine the situation in India.

Chapter 14 also reviews the possibilities of raising capital privately and suggests a number of areas in which competition could be introduced. Chapter 15 describes the 1986 reorganization of a part of the Indian domestic telecommunications network into a wholly government−owned public limited Bombay and Delhi

telecommunications company, with attention to the conditions, objectives, constraints, structural characteristics, and directions taken. The chapter assesses a number of factors that, according to the author, have contributed to increasing productivity and efficiency and have thereby helped meet some of the government's aims in

restructuring. In contrast to India's government, the government of Malaysia restructured the entire

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telecommunications sector and established a telecommunications company at the beginning of 1987 as a first step toward partial and perhaps full privatization (Chapter 16). Thus the process being followed in Malaysia is in a sense similar to that in Sri Lanka: a phased restructuring that allows time and opportunity for adaptation at each step.

Part IV (Chapter 17) concludes by summarizing the alternatives for the future that are open to the developing world. It distills the essence of the seminar material while at the same time capturing the main points of the lively exchanges that took place following individual presentations, in small discussion groups, and during the

concluding session.break

PART I—

THE CHANGING WORLD OF TELECOMMUNICATIONS

2—

Emerging Issues in World Telecommunications

Timothy E. Nulty

The world environment of telecommunications has changed dramatically in recent years and is continuing to do so at an accelerating rate. Merging communications and computer technologies have sparked innovations that are transforming global and local activities of all sorts. No economic, political, or social entity is exempt from the influence of the telecommunications revolution.

The pressure on traditional telecommunications systems stemmed from changes in technology and first became acute in the United States about fifteen years ago. Since that time, the U.S. telecommunications industry and related government policy have drastically changed. It remains to be seen to what extent the changes that have occurred have been desirable. it is certain, however, that the pressures on the old system were irresistible and that change of some sort was inevitable.

Although the pressures in question were first felt in the United States, they are not particularly American in either nature or origin. During the last five to seven years, they manifested themselves throughout the industrialized world and caused profound changes in the policy and structure of the telecommunications sector. It was inevitable that the seismic ripples of the telecommunications earthquake would reach the developing countries, where they are further complicated by the special problems of developing economies.

This chapter reviews the forces underlying the worldwide process of change and the effects on the entities that provide telecommunications services. It also discusses the implications for developing countries, raises issues pertaining to sector development and to options at the levels of national policy and sector and company structure, and examines the nature and role of the dominant telecommunications enterprises in the wake of sector reform.

The concluding remarks highlight the growing importance of sector policy and regulation.

Pressures on the Telecommunications Sector

Telecommunications has traditionally been viewed as the quintessential public utility. Economies of scale, combined with political (including military) sensitivity, created high entry barriers and large externalities.

Telecommunications was believed to be a natural monopoly, an essential public good that government should provide in a noncommercial mode. Within this environment, development focused primarily on the extension of

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standard service, the building of basic networks, and improvements in the performance of the operating entities.

The Telecommunications Revolution

During the last thirty years, the pace of technological change in telecommunications has gradually increased;

breakthroughs during and immediately after World War II (for example, microwave transmission and transistors) were quickly followed by the emergence of new fields of industrial development (for example, integrated

microcircuits, satellites, and optical transmission). In the last ten years the process has reached a turning point and has become a true technological and economic revolution. Several features have characterized this revolution.

Lowered Barriers to Entry.

In 1970, for instance, a private automatic branch exchange (PABX ) was acontinue

roomful of electromechanical switches manufactured by one of approximately a dozen firms. There are currently more than four times as many manufacturers because startup costs for new companies dropped from millions of dollars to hundred of thousands of dollars with the increased availability of standardized integrated circuits and system software. The costs of basic network components, including electronic switches, cables (now increasingly optical), microwave links, exchange termination assemblies, multiplexers, and so forth, have plummeted per bit transmitted. Costs have similarly dropped for alternative facilities such as cellular radio, small satellite terminals, and phone patches for simplex radio—technologies that have made it cheaper and easier for customers and competitors to communicate by means other than the traditional public switched telephone network.

Changed Cost Structures for All Other Industries.

The relative cost of processing and transmitting information, as distinct from any other factor of production, has declined steeply. In 1983, for instance, it cost US$12,00014,000 per month to lease the U.S. half of a private transatlantic voice channel. Today the cost is $4,0005,000. The new TAT −8 submarine cable will carry a similar price. The precipitous decline in the cost of information transmission and processing has stimulated its use in more and more areas. In merchandising, new systems integrate retail transactions at the cash register with purchasing and inventory management. In manufacturing, there are systems for integrating dispersed worldwide sourcing and production with inventory and orders or for centralizing computer aided design. Systems now used in oil drilling permit the analysis from a central location of a rig's seismic data and facilitate management of the rig's activity. Still other systems coordinate and improve the dispatch of aircraft, ships, trucks, and trains used in transport with information regarding fuel and loads. Global publishing networks permit a book or newspaper article written in one country to be mocked up in a second, typeset by computer in a third, and then transmitted by satellite for printing anywhere in the world. All of these systems have drastically altered the cost structures in their respective spheres.

New Services and New Ways of Delivering Traditional Services.

As information and communication techniques are extended, they have been continuously adapted to the specific needs of widely differing activities. The result has been a proliferation of new services. U.S. judicial opinions, for example, are abstracted and entered into an electronic data base by clerical workers in the Republic of Korea, are stored in Mead Data Central's computers in the United States, and are accessed by lawyers all over the world—an essential service for firms wishing to do business in the U.S. market. Similar data networks exist for medicine (supplying information on the latest drugs, diagnostic data, and so forth) and agriculture (new seeds, pesticides, and market information). Engineers in Pakistan produce drawings for architects working in Stockholm on a project in Saudi Arabia. Computer programmers in India write software for Texas Instruments in Dallas.

Keypunch operators in Barbados service data processing operations anywhere in the world. Even traditional telephone service has been transformed. Modern switching and signaling techniques have generated new voice

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services, such as those used for airline booking, in which a call to, say, Pan American World Airways from any local telephone (for example, in Boston) is automatically routed to any open booking agent at any point in the airline's network (for example, in Miami) from which bookings—for hotels and rental cars as well as for flights—can be made worldwide.

As more and more transactions have been shifted to electronic media, the superior intrinsic abilities and lower cost of these systems have, in turn, made their use more widespread. The effect has been explosive. Transactions on the Society for Worldwide Interbank Financial Telecommunications (SWIFT ) network, for example, have grown from 20,000 per day in 1977 to 700,000 per day in 1985. The Reuter Monitor and Dealing system had 50,300 terminals in use in December 1984 and 71,450 by December 1985.

The most explosive growth is attributed to communication with and among computers. Although conventional telephone conversations still account for the bulk of world telecommunications traffic, by one estimate data traffic is increasing by 2030 percent per year. The distinction between voice and data, however, is misleading for two reasons. First, technically, it is increasingly meaningless; there is no difference between voice and data in a digital system (like telex and facsimile, voice is merely one of the many types of streams of ones and zeros that do not require very great speed). Electronic mail between personal computers is not only data traffic but also a direct substitute for voice communication. Second, the artificial distinction between voice and data fails to take into account the real impact of the telecommunications revolution, namely the transformation of world markets into integrated global information systems based on electronic interchange. The interchange includes many speeds and varieties of communications, including voice. Participation in international finance at the present time, for

instance—hard

as a major borrower, as an investor, or as a banker—requires access to telecommunications and information systems that connect the financial centers around the world twenty−four hours a day, whether for voice

communication or for data exchange. The same goes for the tourist and travel industries, commodities exchange, fashion design, and many other activities.

Effects on Telecommunications Entities

In short, the global economic system is increasingly integrated and electronic: without adequate access to the systems by which the world's business is done, no company can do business in the world. First, access to reliable telecommunications has become an economic necessity for the most powerful interests in every country. Second, the technological revolution has multiplied the available forms of telecommunications access and has drastically altered their costs. These two developments are generating enormous pressures, from both the demand and the supply sides of the industry, on existing telecommunications organizations in all countries.

On the demand side, as more and more companies and individuals perceive that access to adequate

telecommunications services is essential to their livelihood, they try to make telecommunications entities provide the needed services. If the entities are unable to respond adequately, and at prices the customers consider

reasonable, customers are driven to seek other remedies. Not infrequently these unsatisfied customers include some branches of government—the military, railroads, power utilities, major state enterprises, and so on.

On the supply side, sources of telecommunications services that represent alternatives to the offerings of the telecommunications entities are increasingly available. Aggressive suppliers of equipment, systems, and services are proliferating and are actively seeking new customers, especially, but not solely, among large, internationally active firms. Once domestic entities—firms or government departments—have decided to install some form of dedicated system, this system usually has excess capacity (or can be designed for more capacity at little additional cost) that can be made available to other users. Examples, licit and otherwise, abound. Major cases, such as the high−capacity optical backbone network being built by the Indian railways and facilities being operated in many

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countries by oil companies, banks, power utilities, and pipeline companies are well known. In addition, however, there is an increasing incidence of smaller, informal alternative systems. Virtually any visitor to Argentina will have noted the myriad illegal extension lines festooning the buildings of downtown Buenos Aires. Indeed, any PABX can be (and increasingly is) used to form the basis for a private telephone system capable of internal communications (often over privately erected outside lines of doubtful legality) and capable also of providing limited access to the public switched network. Similarly, in rural areas, phone patches available for purchase permit any existing telephone line to be converted (legally or illegally) into a base station for simplex citizen band radio connections to the national public telephone network. In a number of countries, medium and large users in non−metropolitan areas (singly or in groups) are considering or even building local switched (mobile or fixed) radio−telephone systems connected either to satellite facilities for international service or to specially provided private lines and trunks for connection to the national network. Again, some of this activity is overt (blessed or tolerated by the telecommunications entity), and some of it is covert (condoned or winked at by the government).

Constraints on Operating Entities

Customers need more and better telecommunications services and have more alternatives for acquiring them if the telecommunications entity fails to provide. The power of the customers and the variety and flexibility of the technical alternatives ensure that customer demands will persist and will be met one way or another.

At the same time, telecommunications entities are prevented by a number of powerful factors from responding rapidly and effectively to changing demand and to the availability of alternative supply. The constraints often include: (a) limits on the entities' ability to invest (due to government constraints on new budget resources and on the amount of operating surpluses that may be reinvested and due to limitations on the telecommunications entity's ability to raise capital elsewhere); (b) obligations to serve high−cost customers; (c) political and legal restrictions on the extent to which prices or services may be changed; (d) institutional structures derived from the civil service that are ill suited to cost−conscious, customer−oriented commercial activity; and (e) constraints on sources of equipment. Difficulties in responding to market challenges further encourage disappointed customers to seek alternative sources—and encourage alternative suppliers to provide them.

Before telecommunications entities can improve their performance and retain customers, they must be relieved of these burdens. Telecommunications entities must have more freedom to invest in needed facilities, to reduce costs, to improve quality, and to set pricescontinue

economically. They must also be subject to greater discipline to ensure that the greater freedom is actually used for the intended ends and not merely to protect monopoly positions or to perpetuate inefficient modes of operation. In other words, telecommunications entities must be permitted—and required—to behave more like commercial businesses under conditions of competitive market discipline.

Implications for Developing Countries

The pressures on the governments and telecommunications entities of developing countries are similar to those being felt throughout the industrialized world and even the socialist bloc countries. As previously noted, these forces have already changed the global landscape dramatically: they have brought deregulation and divestiture in the United States, privatization in the United Kingdom and Japan, competition in international services and facilities, and liberalization and competitive challenges in Europe.

Additional Difficulties

Newly industrialized countries and developing countries face complications in addition to those that confront industrialized countries: (a) industrialized countries built their basic national networks during the era of relatively

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unchallenged monopoly control, a period without a counterpart in developing countries; (b) budget problems in developing countries create little opportunity for increasing investment from traditional sources, but at the same time capital markets are thin, so that the option of borrowing to supplement internal cash generation to increase growth is limited; and (c) intense needs for scarce investment resources, especially those requiring foreign exchange, reduce tolerance for excess capacity.

The capital plant of the public networks of North America, Europe, and Japan is worth roughly a trillion U.S.

dollars. The enormous task of building national networks was relatively easy in the industrialized countries because the traditional telecommunications monopoly could dictate uniform standards, could charge what the market would bear in profitable areas, and could use the revenue to subsidize expansion in other areas that were not immediately profitable.

The new pressures to be competitive—especially in the business market, which had previously been highly lucrative—reached developed countries only after universal national networks had been built. The need for monopoly integration was therefore reduced. Newly industrialized and developing countries, however, must cope with modern disintegrative pressures as they try to construct basic national networks.

Conflicting Forces

Telecommunications entities in developing nations thus find themselves in a serious bind. On the one hand, technical degradation of the network from overload and inadequate maintenance, potential dis−economies of proliferating and fragmented systems, and loss of revenue to cross−subsidize extension of the basic network are particularly acute problems. Loss of revenues from large customers looms even larger as a problem than it does in industrialized countries because the proportion of total traffic concentrated in such customers is greater. On the other hand, it is very difficult for telecommunications entities in developing countries, in their current form and condition, to provide the services large customers need and demand. If telecommunications entities and

governments respond to the dilemma by forbidding alternative systems without being able to provide the services themselves, the customers—and ultimately the country—will suffer. Furthermore, large users (private and governmental), which are politically and financially powerful actors in their own right, are fully capable of challenging and defeating the telecommunications entities if they believe their vital interests to be at stake.

Newly industrialized and developing countries, however, have some opportunities not enjoyed by the

industrialized countries. Specifically, new technologies provide an opportunity to leapfrog over some of the most expensive and difficult phases of telecommunications development. Advanced radio and satellite technologies, for instance, can temporarily or permanently forestall the need to hard−wire remote rural areas. Then, too, developing countries can go directly to superior electronic digital systems without the expense of phasing out established electromechanical systems.

The pressure on telecommunications entities comes precisely as governments find themselves increasingly strapped for funds. In addition, it affects operating entities that, although often profitable, are nevertheless usually inefficient, poorly managed, and ill equipped to respond quickly or imaginatively to new demands and

contingencies. The inability of governments and telecommunications entities to react with adequate speed is causing real political difficulty. Dissatisfaction with telecommunications is becoming front page news in developing countries. Governments are beginning to feel that failure to deal with this discontent seriously threatens not only development in general but also at times even their own political survival.break

Move toward Sector Reforms

The governments of developing and newly industrialized countries are thus being forced to reevaluate telecommunications to seek ways of loosening the constraints that keep the sector from improving its

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performance. Meanwhile, major users are pressing ahead with building their own networks, whether or not the existing telecommunications entities participate, and all countries are grappling with ways of coordinating the proliferation. Asia and Latin American governments will feel the pressure most acutely; their telecommunications markets are expected to grow at 1011 percent for the next five years, compared with the world average of 8.3 percent per year.

In the effort to respond to these pressures better and to reduce the constraints on the telecommunications

providers, many newly industrialized and developing countries, like their industrial counterparts, are considering reorganizing the telecommunications sector and the provision of telecommunications services. The reforms have many purposes: to hasten the rate of growth in both new and traditional telecommunications services, to improve responsiveness to customer and economic pressures, to increase efficiency and cost discipline in the

telecommunications provider(s), to open fresh avenues for innovation, and to attract new investment and business into a booming industry.

Issues of National Policy

Efforts to reform telecommunications in developing and newly industrialized countries to deal with the changing world environment raise new issues and change old ones. Such issues arise at every level. I will discuss issues both of national policy and of sector and entity structure.

Underinvestment

Telecommunications has traditionally been given low priority in the plans of developing countries. Today's environment requires that the telecommunications investment be increased, as many governments

understand—but by how much? And at the expense of which other sectors? How can the increased investment be accomplished in the face of near universal fiscal stringency?

A very strong case can be made for expanded telecommunications investment in most developing countries in terms of high economic returns, large gaps between supply and demand, demonstrated user willingness to pay fees in excess of official tariffs, and evidence that telecommunications shortages in other sectors have adverse effects. Furthermore, the proportion of a country's investment actually devoted to telecommunications is increasingly a market−driven amount, independent of nominal government policy. If the telecommunications entity does not invest enough to meet a sufficient proportion of customers' demands, many customers will procure services or facilities elsewhere by one means or another. It is increasingly difficult to stop this trend: many of the affected customers are other government departments, large firms, and parastatals with sufficient influence to prevail.

In such a situation, telecommunications investment must grow so that it satisfies customer demand enough to discourage excessive or uneconomic alternatives. It is not realistic, efficient, or desirable, however, for the established telecommunications entities to meet all customer demands. Customers should therefore enjoy some freedom to seek alternatives for the remainder of their needs, especially in newly industrialized and developing countries, where constraints on the entity's ability to mobilize additional financing are severe. New providers in selected market segments can by their presence increase the total resources available for telecommunications investment and in particular can reduce the effect of public sector budgetary restrictions on telecommunications growth. This benefit, however, must be balanced against the dangers of excessive redundancy and poor

interworking. Proper balancing can best be accomplished by an explicit policy and enforcement mechanism covering interconnection standards, obligations, and prices (this subject is discussed more extensively in Chapter 4).

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Foreign Exchange

Although telecommunications is often a profitable undertaking—even when the service is poor and the entity is badly run—it does not generally earn foreign exchange directly. Some exceptions, resulting from either

asymmetrical international traffic (for example, in El Salvador) or special revenue−sharing agreements (for example, between Mexico and the United States), reflect major differences in costs. In most developing countries, however, telecommunications investment is highly foreign exchange intensive. The result is a dilemma in places where, as in most developing countries, foreign exchange is scarce.

Foreign exchange shortages do not, however, prevent meaningful gains. In fact, significant improvement in service is possible without large purchases of imported equipment through better management, maintenance, traffic engineering, billing, and so forth. This point is even truer wherever a significant domesticcontinue

manufacturing sector supplies telecommunications equipment to support such improvements. In these countries, better performance of the telecommunications manufacturing industry (for example, by emphasizing

management, quality control, and delivery performance) is crucially important and need not involve proportionate amounts of foreign exchange. (I do not mean to suggest that the necessary reforms will be easy.)

Furthermore, improved telecommunications services increase foreign exchange earnings and savings. Tourism and many export industries require high−quality access to world market information and communications. Several studies show that telecommunications services and foreign exchange earnings are highly correlated. Likewise, telecommunications permits more efficient use of imported vehicles and fuel, effective distribution of food and supplies, and other improvements that reduce foreign exchange costs to the economy overall. Still,

telecommunications entities are rarely permitted to develop pricing mechanisms that capture some of these foreign exchange gains.

Distributional Equity

Access to telecommunications services is, and will always be, a politically sensitive issue because it confers differential commercial and political advantages on those who have it. A purely market−driven system of allocation will tend to produce a system that concentrates disproportionately in the main cities and on the largest and wealthiest customers. This concentration causes political problems and can impede the realization of important development goals, such as the decentralization of economic activity and the development of rural areas. But the commercial pressures that are reflected by concentration on high−density, high−income customers, sectors, and regions cannot, and should not, be ignored.

Telecommunications services in developing countries, besides being insufficient to meet demand in general, are concentrated in major urban areas. This imbalance reflects neither a lack of communication needs in rural areas nor an inability to pay. Studies have shown that rural telecommunications services are used mainly in connection with economic production and distribution and that they exhibit high rates of economic return. There is anecdotal evidence that a high cost is imposed on other productive sectors (for example, transportation) and on delivery of social services (for example, health, education, and security) by the lack of rural telecommunications.

Furthermore, significant benefits associated with the quality of life (for instance, access to friends and kin) arise from rural telecommunications. Not surprisingly, there is a large overt demand for rural services in most developing countries, even at prices that reflect the full cost of delivery—to say nothing of the hidden demand that emerges only once services have become readily available.

The relative backwardness of telecommunications in rural areas partly stems from the fact that unit costs of expansion, operation, and maintenance are high relative to those in densely populated cities. Rural services are thus less profitable (at prices constrained by nationwide average costing practices) than urban services. Coverage

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of numerous small and scattered places also places a heavy burden on manpower and organiration. Faced with limited resources (financial and institutional) and with large unmet urban demands, the telecommunications entities have understandably not pushed aggressively to expand in rural areas. Increasing emphasis on business−oriented management in telecommunications entities (generally desirable) will tend to intensify the resistance to rural expansion.

The objectives of the telecommunications enterprise and broader national priorities regarding rural development, access to basic services, and income redistribution are thus often in conflict. Resolving this conflict involves both making the rural telecommunications investments more cost−effective and adjusting sector policy and

organization.

Reconciling Equity and Commercial Objectives

The goals of distributional equity and commercial efficiency can never be fully reconciled, and political

judgments must ultimately be made. Still, there are several ways of minimizing the conflict between the two and of simplifying the political choices.

Rural Services.

Rural services should be carefully tailored to rural circumstances. Traffic characteristics and environment in rural areas differ from those in urban areas. Rural installations, for example, comprise relatively few stations covering large and often remote areas, so that average distances are long and traffic per route low. Some individual stations, however, may be used very intensively and may have average traffic per line well in excess of that in cities. Also, rural areas communicate mostly with towns and cities rather than with other rural communities.

Extreme environmental conditions are common, power supply is often unreliable (or nonexistent at intermediate points between communities), and all−year access is not assured. All ofcontinue

these conditions indicate that rural areas need different types of services, different network configurations, and different technologies. The choice is further complicated by uncertainties regarding the availability and price of some solutions (such as spare satellite capacities), by interdependence with policy decisions in other sectors (for example, domestic manufacturing of small earth stations), and by the proliferation of new options for rural use in developing countries.

Diversifying Supply.

An important reason for the perceived unprofitability of rural services is that most national telecommunications entities must operate with more or less uniform nationwide pricing. Theoretically, if the entities were able to differentiate prices by regions, even high−cost remote telecommunications services could be profitable. This is seldom a viable option, however, from the political and administrative standpoints. Furthermore, most developing countries face institutional difficulties in maintaining an effective management presence in rural areas. In view of these practical problems, it may often be desirable to permit other entities to provide some or all

telecommunications services in areas where the existing entity is reluctant or unable to meet demand. Other entities could substitute for complete local networks or for any of the following: trunk connection to the rest of the network, local lines and switching, terminal equipment, and extra services such as weather or market data. Also, there are often economies of scope (lower costs or additional benefits from combining various services); for example, a single facility might include a public telephone, a postal agency, a simple audio conferencing room, and a small data and information service. The experience in the United States, Finland, and some developing countries suggests that small local companies or cooperatives can provide some services and facilities satisfactorily, thereby facilitating the development of rural services without burdening the principal

telecommunications entity. In addition, such enterprises can often mobilize local management skills, tap new

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sources of capital (for example, farmers and local businesses), lower overhead, and perhaps reduce cash outlays for investment through self−construction by users (for example, pole erection, trench digging, and small building construction). Disaggregated provision of rural services, however, requires changes in the regulatory framework, especially with regard to sector organization and ownership, pricing to final users, interconnection to the main networks, and technical standards. It also requires setting up financing mechanisms and specialized technical and management support.

Subsidy.

Service to rural or remote regions can be subsidized. In general, commercial considerations should determine the telecommunications entity's own resource allocation, but there should be compensating mechanisms for

subsidizing the extension of service to regions and groups that represent a loss from the operator's standpoint but that it is in the national interest to serve. All countries have such subsidies, whether explicit or implicit. The question is not whether to subsidize but how to subsidize in order to derive the maximum benefit for the lowest cost.

As much as possible, subsidies should: (a) remain separate from the pure commercial cost−related pricing mechanisms of the telecommunications entity; (b) be explicit; (c) be regularly reevaluated to prevent vested interest in their continuation from becoming too strong; and (d) have a built−in bias to decline automatically.

If a service is valuable to its customers, this value should be reflected in an increasing willingness to pay over time and hence in increasing capacity to generate revenue. The degree of subsidy should thus decline over time (without necessarily disappearing). If a service is unable to survive any reduction in subsidy over time, then in principle it is probably not worth its cost even when externalities and national interest are taken into account.

Once a subsidy is in place, however, it can prove politically difficult to remove. Thus, all subsidy mechanisms should have a built−in automatic tendency to decline. Affirmative action is then needed to mainrain the subsidy rather than to remove it.

Sometimes the need to subsidize arises not from the inherent structure of cost and demand but from an institutional limitation on the ability to change prices. National telecommunications entities, for example, are usually constrained by nationwide averaging principles so that they cannot charge higher prices in high−cost areas even if customers would be willing to pay them.

Implementing Subsidies.

The many mechanisms that may be used to implement subsidies include the internal and external (to the operating entity), the monetary and in kind, and the public and private. Only vague information, if any, typically exists on the flow of subsidies. (Indeed, the very concept of a subsidy is not without problems in an industry where so much of the cost structure is overhead and where two−way networking complicates externalities among customers.) Hence there is no clear idea of who really pays, who really benefits, whether the benefits are worth whatever costs are involved, and so forth. As the pressure rises to improve services with limited resources, the situation becomes increasingly intolerable.break

The first requirement is for better information on the flow of subsidies. The second is for mechanisms to permit subsidies to be reviewed in the light of national policy—to ascertain whether they are going to the regions and people they are intended to reach and whether they are accomplishing the things desired. These mechanisms must include the telecommunications entity but must not be dominated by it. Third, the method for actually collecting and distributing subsidies must abet the first two and must be as simple and corruption−free as possible.

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Policy Options.

Within these guidelines, a number of specific options can be examined. Pricing principles and tariff−setting practices based on full cost recovery, for example, could be allowed to prevail where government believes that a market approach is adequate. Elsewhere, startup or recurrent subsidies may be considered in view of the

investments' economic and other merits and the government's development objectives. Cross−subsidy could take place within the telecommunications entities by means of interconnection tariffs between telecommunications enterprises, by tax or credit incentives for rural telecommunications investments, or by government budgetary allocations.

Issues of Sector Structure

What entities should be in the sector? What services should each one provide as a monopoly or in competition with other providers? What other providers exist now and what providers should be permitted in the future? What are the rules for entry, exit, interconnection, and pricing? These questions are preoccupying all governments.

Sector Composition

It has already been argued that a degree of diversity in the supply of telecommunications services is needed in order to mobilize additional investment resources, reconcile equity and commercial objectives, and increase the sector's implementation capacity. Furthermore, in the changing sector environment, no single telecommunications entity can provide efficiently and at reasonable cost all the services that all its customers might want. Networks are designed to optimize on particular traffic characteristics—they cannot do everything, and certainly cannot do everything efficiently. Too much attention given to special (mostly large) customers will detract from the basic service. But if too little attention is given to special services, large users will either obtain them elsewhere (thereby reducing the surpluses needed by the telecommunications entity to finance national network extension) or will not get them at all (suffering damage when these services are needed, often to make the customer

competitive internationally). Freedom for customers to procure their own facilities or services is desirable in order to put pressures associated with cost, quality, and innovation on the telecommunications entities. If customers and competitors are allowed complete freedom, however, too much of a developing country's scarce resources may be spent on building redundant or incompatible systems.

Basic Issues

Governments have little choice but to seek a balanced regime consisting of some combination of monopoly and other providers of facilities and services. The question is not whether to have such a mixed system but how to structure it so that it is orderly and efficient.

The best solution depends on each country's circumstances and goals. The United States emphasizes the

distinction between basic and enhanced services, Japan separates providers of facilities and services, and France debates open and closed networks. All approaches, however, must address essentially the same issues.

Which services or facilities should remain, on economic or political grounds, the exclusive preserve of the telecommunications entity? Which should be open to other providers rather than or in addition to the existing entity?

what rules should govern interaction within the competitive sphere and between the monopoly and competitive spheres (for example, rules regarding conditions for entry, interconnection standards and prices, and allowable competitive practices) so as to create a level playing field and promote efficiency?

What institutional arrangements should: (a) monitor and enforce the rules? (b) resolve disputes between and

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among parties? and (c) review and amend the points above as necessary, depending on circumstances?

These issues must be addressed collectively, or inconsistency will make seemingly rational solutions untenable. A policy decision to permit competition in the subscriber terminal equipment market, for instance, without rules governing whether or how the operating entity can do business in this market, and without a mechanism for enforcing these rules, may cause the entity to package terminal equipment with services and may thereby kill competition. The same goes for value−soft

added services, which can be provided either as add−ons by new firms or as part of a packaged basic service by the existing entity.

Major Options

For most developing countries there are five main ways of reducing or restructuring the involvement of the existing telecommunications entity: (a) diversifying and separating the supply of subscriber equipment; (b) establishing separate business networks; (c) allowing dedicated networks to offer services to others; (d)

diversifying the provision of value−added services; and (e) subcontracting works and services. In most developing countries, 2030 percent (by value) of the telecommunications entity's current activities could be undertaken by other entities without undermining the economic viability of the first provider. (Chapter 12 examines this subject in greater depth.)

In addition, national monopolies can be divided into separate regional operations. For decades, both developing and advanced countries showed a trend toward consolidation of local and regional telecommunications entities into national companies. The process may have gone too far, producing overcentralized entities. The breakup of American Telephone and Telegraph (AT&T ) was the first major move in the opposite direction. More recently, in India the Bombay and Delhi networks were split off into a separate corporation. Although consolidation of very small entities should generally continue in developing countries, especially as few of the small operators can afford to modernize and expand rapidly, the initial succes of India's Bombay/Delhi corporation suggests that at least regional decentralization should be given more attention in the larger developing countries.

Another way of splitting supply among several providers is on the basis of whether services are local, national, or international in coverage. In developing countries local, domestic long−distance, and international services may all be provided by the same enterprises (as they are in Pakistan), or international services may be separate (as they are in India), or local services may be separate (as they are in Colombia). Each approach has its pluses and minuses. Smaller firms are easier to manage and are more responsive to their users and communities, but loss of scale and coordination cause problems. Because customers are able to pay high prices, and the service is

extremely important to them, international services are a major source of potential subsidies to support extension of the domestic network. In general, there is no reason for disturbing any well−functioning system that meets the particular country's needs (for example, Sweden and Norway each with a single telecommunications entity, Denmark with seven, and Finland with about sixty). Where several enterprises are involved, however, the critical issue is usually revenue sharing. International long−distance services, and to a lesser extent domestic ones, tend to be more profitable than local service in developing countries, largely because they receive most of the revenue from lucrative international traffic but incur relatively little of the costs, most of which are embedded in the local network. The result is high−quality international service once calls reach the international gateway exchange but poor, resource−starved urban and rural networks. A combination of interconnection charges and taxes should be levied, or the agreement on sharing of international revenues should be revised, to ensure that the international services make a reasonable contribution to the support of the development of the national telecommunications network. Such development ultimately benefits everyone, including the international callers.

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Sector Pricing

Inseparable from the issue of sector structure is sector pricing. In fact, pricing structure can ultimately determine sector structure. The traditional question for telecommunications tariffs was relatively simple, namely how to generate sufficient revenues to cover costs and make available a reasonable proportion of funds needed for expansion. Additional tariff objectives have more recently been coming into focus: the efficient allocation of the supply of services and the mobilization of surplus funds for use by government in other sectors.

Pricing is complicated because of the emerging potential for competitive supply, an issue that distinguishes telecommunications from some other traditional public utility sectors (such as power and water supply) in which alternative supply is at present not an issue. In this respect telecommunications resembles transportation. Like transportation, telecommunications as a sector was originally dominated by one mode (railroads for

transportation, telephones for telecommunications); the owner of the ''roads" and the owner of the "vehicles" was the same, and the economics of the sector were dictated by this integration. Like railroads, telecommunications entities face pricing problems. The traditional public utility questions of how to recover huge fixed costs where marginal costs are low and facilities are not easily moved are compounded by the emergence of competition from entitles with very different cost characteristics. (Pricing is dealt with in more detail in Chapter 4.)break

The Nature and Role of the Dominant Telecommunications Entity

Most countries, including most developing countries, are under mounting pressure to improve and extend service rapidly; to provide new services to certain classes of customers; and to reduce the drain on increasingly tight government budgets (and, in many places, make a positive net contribution to the government budget). As noted above, this situation suggests increasingly complex sector structures. Nonetheless, a single telecommunications entity is likely to remain dominant as custodian of the national network and as supplier of last resort. To achieve the desired goals it will therefore be necessary for the dominant entity to increase both the efficiency with which it uses resources and its flexibility with respect to resources and ways of doing things. It will also be necessary to put some distance between telecommunications operations and the political process. (Both sides are interested in this greater separation; politicians do not want the rising dissatisfaction with telecommunications service to be laid directly at their doorstep; telecommunications entities do not want constant political interference in their operations.)

Corporate Governance

Greater efficiency, greater flexibility, and greater distance from the political process all suggest a movement toward greater autonomy, commercial orientation, private participation, and competitive discipline on costs, services, and prices. In general, shifting the telecommunications entity farther from government provides the opportunity for greater efficiency in the commercial sense. This development is desirable in a technical and economic environment in which telecommunications is becoming less like the traditional, natural monopoly public utility and more like, say, the computer industry. There are dangers, however, First, the opportunity for greater efficiency may not be realized because more independent (including privatized) operators may take advantage of continuing monopoly powers to make profits by charging high prices without improving service or efficiency. Second, national goals of social, economic, and political integration may be ignored or undermined.

Neither of these dangers implies that telecommunications should not be made more independent and commercial.

The implication is rather that steps should be taken to minimize the side effects of commercialization and independence. These steps include the institution of functioning regulatory schemes and some degree of competitive pressure on the dominant telecommunications entity.

To meet the pressures for increased commercial efficiency and improved service, reforms are being considered in a number of developing countries. These reforms fall into two broad categories. First are various internal changes

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Restructuring and Managing the Telecommunications Sector